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Estimating the Effects of a Time-Limited Earnings Subsidy for Welfare Leavers

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Estimating the Effects of a Time-Limited Earnings Subsidy for Welfare Leavers Econometrica, Vol. 73, No. 6 (November, 2005), 1723–1770 ESTIMATING THE EFFECTS OF A TIME-LIMITED EARNINGS SUBSIDY FOR WELFARE-LEAVERS BY DAVID CARD AND DEAN R. HYSLOP1 In the Self Sufficiency Project (SSP) welfare demonstration, members of a randomly assigned treatment group could receive a subsidy for full-time work. The subsidy was available for 3 years, but only to people who began working full time within 12 months of random assignment. A simple optimizing model suggests that the eligibility rules created an “establishment” incentive to find a job and leave welfare within a year of random assignment, and an “entitlement” incentive to choose work over welfare once eligibility was established. Building on this insight, we develop an econometric model of welfare participation that allows us to separate the two effects and estimate the im- pact of the earnings subsidy on welfare entry and exit rates among those who achieved eligibility. The combination of the two incentives explains the time profile of the experi- mental impacts, which peaked 15 months after random assignment and faded relatively quickly. Our findings suggest that about half of the peak impact of SSP was attribut- able to the establishment incentive. Despite the extra work effort generated by SSP, the program had no lasting impact on wages and little or no long-run effect on welfare participation. KEYWORDS: Welfare reform, state dependence, Self Sufficiency Project. OVER THE PAST DECADE the United States, Great Britain, and other countries have reformed their income support systems to enhance the financial incen- tives for work (see, e.g., Blundell and Hoynes (2004)). Traditional means-tested welfare programs impose high tax rates on program participants, reducing or even eliminating the payoff to work. Many analysts have argued that the re- sult is a dynamic welfare trap. Once in the system, welfare recipients have little incentive to work, and the subsequent erosion of their skills and work habits makes it less likely they can leave in the future.2 In the early 1990s the Canadian government funded an innovative demon- stration project—the Self Sufficiency Project (SSP)—designed to test whether a time-limited earnings subsidy could help long-term welfare recipients make a permanent break from program dependency. Unlike the earnings subsidy 1We are grateful to SDRC for research support and for making the SSP data available, and to three anonymous referees, Costas Meghir, Douglas Tattrie, Ken Chay, Guido Imbens, David Lee, Jack Porter, James Powell, Charles Michalopoulos, and seminar participants at UC Berke- ley, University of Melbourne, Princeton University, and University College London for helpful discussions. All conclusions in this paper are solely the responsibility of the authors and do not represent the opinions or conclusions of SDRC or the sponsors of the Self Sufficiency Project. An appendix with our computer programs and some additional results is available from the Sup- plemental Material website. 2See Plant (1984) for an explicit model of a dynamic welfare trap. The idea that welfare partic- ipation creates a dependency trap is very old. For example, Hexter (1917) analyzed the duration of relief spells at a private charity and found that people on relief longer had a lower likelihood of leaving. High implicit tax rates also create incentives to participate in the underground sector: see Fortin, Fechette, and Lemieux (1994). 1723 1724 D. CARD AND D. R. HYSLOP programs of the United States and United Kingdom, SSP was only available for full-time work.3 Moreover, participants had to begin receiving SSP within a year of being informed of their potential eligibility—otherwise they lost all future eligibility. Those who met the deadline were entitled to 3 years of eligi- bility and could move back and forth between welfare and work, receiving the subsidy whenever they were working full time. At the end of the 3-year period they returned to the regular welfare environment. The SSP evaluation used a randomized design. One-half of a group of long-term welfare recipients was offered the supplement, while the other half remained in the regular welfare system. Data were collected for 6 years to mea- sure the short-term impacts of the subsidy and any lasting effects once pay- ments ended. Comparisons between the treatment and control groups show that SSP had significant short-term impacts on welfare participation and work, raising the full-time employment rate and lowering welfare participation by 14 percentage points within the first 18 months of the experiment.4 The effects of SSP faded over time, however. By the third year after random assignment, the difference in welfare participation between the treatment and control groups had fallen to 7.5%, and by 69 months (a year and a half after all subsidy payments ended) the welfare participation rates of the two groups were equal. The key contribution of this paper is to identify, both theoretically and em- pirically, the combination of incentives created by the time-limited eligibility rules of SSP and to investigate the impact of SSP on welfare participation in light of these issues.5 We first develop a simple optimizing model that sug- gests that the rules of SSP generated both an “establishment” incentive to find a full-time job and leave welfare within a year of random assignment, and an “entitlement” incentive to choose work over welfare once eligibility was achieved. Simple experimental comparisons, while valid, confound these two 3The U.S. subsidy program, the Earned Income Tax Credit (EITC), has no hours limitation, while the U.K. subsidy, currently known as the Working Tax Credit (WTC), requires only part- time work (16 hours per week). These programs are mainly available to low income families with children, although recent changes have extended entitlement to other individuals. Phelps (1994) has argued for a general wage subsidy program for all low wage workers. 4A complete final report on the experiment is available in Michalopoulos et al. (2002). This is a larger impact than was observed in other recent welfare reforms experiments in the United States For example, Hamilton et al. (2001) review the 5-year impacts of 11 alternative welfare-to-work experiments on employment and welfare outcomes, and report typical impacts on employment and welfare participation of less than half that reported for SSP. 5To the best of our knowledge, the implications for the dynamic nature of the incentives cre- ated by the time-limited eligibility rule has received little, if any, attention. For example, there is no discussion of this issue in the background paper by Greenberg, Meyer, Michalopoulos, and Robins (1992), which uses a static labor supply model to evaluate alternative subsidy parameters. Similarly, the SSP Implementation Report by Mijanovich and Long (1995, pp. 28–29) mentions six key questions that were addressed in the design of SSP, but the issue of time-limited eligibility is not discussed. The unusual nature of the incentives created by the time-limited eligibility is not discussed in the final SSP Recipient Report (Michalopoulos et al. (2002)) or any of the earlier reports. EFFECTS OF A SUBSIDY FOR WELFARE-LEAVERS 1725 effects. Given the insights of this model, we then develop a dynamic economet- ric framework that combines the experimental randomization associated with SSP with parametric modeling to identify the impact of the selection and treat- ment effects of SSP on welfare transitions. (As noted by Ham and LaLonde (1996), even with a randomly assigned intervention the estimation of dynamic impacts requires a full specification of the process that generates individual welfare histories.) We begin by developing a suitable model of welfare entry and exit behav- ior among the SSP control group. We show that the control group’s outcomes are reasonably well described by a dynamic logistic model with second order state dependence and unobserved heterogeneity. We then augment this base- line model with treatment effects that represent the establishment and entitle- ment incentives of SSP, and a model of the eligibility process that accounts for the potential correlation between the probability of entering or leaving welfare and the probability of attaining SSP eligibility. Our empirical results suggest that the unusual time profile of the experi- mental impacts observed in the SSP demonstration arose from a combination of the short-term eligibility incentive and the longer-term entitlement incen- tives of the program. Indeed, our estimates attribute over one-half of the peak impact of SSP to the incentives created by the time limit on eligibility. This decomposition helps to reconcile the large but short-lived peak impacts of the SSP demonstration with the impacts observed in other experimental welfare reforms. Our estimates also suggest that members of the program group with a higher probability of leaving welfare were more likely to establish entitle- ment for SSP. As a result, differences between the observed transition rates of the SSP-eligible subgroup and the control group overstate the causal effect of the supplement, even in the later years of the experiment. Finally, our analysis of wage outcomes shows that SSP had no lasting effect on wages, despite the extra work effort engendered by the program’s incentives. Thus, while the pro- gram generated a short-term reduction in welfare dependency, it had little or no permanent effect on long-term self-sufficiency. 1. THE SSP DEMONSTRATION—DESCRIPTION AND OVERVIEW OF IMPACTS A. Income Assistance Programs and the SSP Recipient Experiment Under the regular welfare system available to low income families in Canada, known as Income Assistance (IA), payments are reduced dollar-for- dollar for any earnings beyond a modest set-aside amount.6 The implicit 100% tax rate on earnings, coupled with the availability of other benefits (e.g., free 6The IA program is operated at the provincial level, but all the provincial programs share several important features, including a dollar-for-dollar benefit reduction rate.
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